Connect gearing and interest cover
Use capital structure and earnings cover together to describe borrowing exposure without claiming certainty.
Exam scope and assessment notes
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. Use the ratio formulae in the syllabus appendix exactly; Cambridge states these are the only formulae accepted. Use year-end balances where appropriate unless the question specifies averages, and round to the requested number of decimal places. Practice is self-checked, not an official Cambridge grade. Full timed Papers 1–4 and human subject-teacher review remain outstanding.
Before you begin
- Use the AS Topic 1.6 ratio, financial-statement and stakeholder skills. These lessons add only the A Level ratios and interpretation required by Topic 3.5.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
Which ratio uses issued shares, reserves and non-current liabilities in its denominator?
What you will learn
- Explain how gearing and interest cover measure different dimensions
- Link trends to repayment and profit risk
- Make a cautious lender-facing conclusion
Separate the capital mix from its interest burden
Gearing measures non-current liabilities as a share of the defined total capital. Interest cover measures profit from operations divided by interest payable. One describes how the business is financed; the other describes current operating-profit coverage of interest.
High gearing with weak or falling cover can be a warning because fixed obligations sit alongside limited profit headroom. Low gearing with strong cover can appear more resilient, but neither ratio includes all cash-flow timing, principal repayments or future uncertainty.
Use a trend and the loan terms
Check whether borrowing financed productive assets, whether operating profits are stable and when interest or principal is due. A fixed-rate loan and a floating-rate loan expose the business differently when rates change.
A lender recommendation should use relevant cash forecasts, covenants and repayment schedules. Ratios help identify questions; they do not replace a credit decision or guarantee repayment.
Pause and explain
Gearing falls but interest cover also falls. What should the analyst do?
Worked example
Gearing rises from 30% to 45% while interest cover falls from 8 to 4 times. State a supported concern and one evidence request.
Show the worked solution
- The business relies more on non-current liabilities in its capital mix.
- Operating-profit coverage of interest has weakened.
- Ask for cash-flow forecasts, loan terms and the reason for new borrowing before recommending a lending change.
Answer Together the trends signal increased financing pressure; examine cash flows, debt terms and the purpose of borrowing before concluding.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
A company's gearing falls from 50% to 35%, but cover falls from 6 to 3 times. Give a balanced conclusion.
Give me a hint
Lower gearing and weaker interest cover point to different dimensions.
Compare my reasoning
- The defined share of capital from non-current liabilities has fallen.
- Operating-profit coverage of interest has also weakened, reducing the current earnings buffer.
- Check whether interest costs rose, profit fell or debt was restructured, and review cash flow and principal dates.
Capital gearing improved on this measure, while interest coverage weakened. Investigate profit, interest and debt terms before judging overall risk.
Look for these in your work
- Identify the gearing decline.
- Identify the cover decline.
- Request evidence on profit, interest and repayment timing.
A lender's client has gearing 25% and interest cover 2 times. Explain why neither figure alone establishes whether a new loan is affordable.
Give me a hint
Look beyond the capital mix and current interest measure to future cash commitments.
Compare my reasoning
- Gearing describes the capital proportion from non-current liabilities but not cash available to repay principal.
- Interest cover reflects current operating profit relative to interest but not its timing, volatility or future rates.
- Request cash-flow forecasts, loan schedule, covenants and the proposed loan's purpose and expected return.
The ratios show different parts of risk. Affordability needs cash-flow timing, principal terms, covenants and realistic forecasts.
Look for these in your work
- Explain what gearing measures.
- Explain what interest cover omits.
- Request loan-specific cash-flow evidence.
A company plans to borrow for a factory expected to raise profit in three years, but its current cover is 2 times. What conditions could a lender use to manage uncertainty?
Give me a hint
Balance expected long-run returns with short-run ability to meet obligations.
Compare my reasoning
- Review construction cash flows, interest during the project and repayment dates before lending.
- Stress-test lower sales, delays and higher interest rates and test covenant headroom.
- Consider staged drawdown, monitoring or covenants while avoiding a claim that the expected return is guaranteed.
Assess cash flows and stress cases, then consider staged funding and covenants. The project's forecast benefit does not remove short-term repayment risk.
Look for these in your work
- Review timing of cash inflows and repayments.
- Stress-test delays, lower sales and rates.
- Suggest proportionate conditions and monitoring.
Common mistakes
- Treating the ratios as interchangeable
- Ignoring principal repayments
- Calling high gearing automatically unacceptable
What can you explain now?
Which ratio measures operating profit relative to interest payable?
Compare with the explanation
Interest cover
Interest cover gives operating-profit coverage in times.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
Explain in one sentence how gearing differs from interest cover.
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.